It's already about March -- Here's what to expect from the Fed's big statement tomorrow

Federal reserveFlickr / Federal ReserveBoard of Governors meeting, January 1, 1922

The Federal Reserve is not likely to raise interest rates again this week.

Rather, its policy statement on Wednesday afternoon will be all about clues on how it will handle its next big decision in March.

It’s almost unanimously expected that the Fed will leave the target of the benchmark Fed funds rate unchanged in a range of 0.25% – 0.50%.

This means the focus on Wednesday will entirely be on the wording of the statement.

The Fed is likely to maintain that the US economy continued to grow at a moderate pace between the December 15-16 meeting and this week’s gathering.

Remember that the previous Fed statement was just released last month and while a lot has changed in markets since then not nearly as much much has changed in the economy. The Fed’s two-day meeting this week also comes just before the fourth-quarter and full-year GDP numbers are released Friday.

Deutsche Bank’s Joseph LaVorgna pointed out in a client note that following the drop in December retail sales the language on consumer spending may get downgraded. However, the stunning pace of job gains during the same month balances the Fed’s assessment of risks to their outlook, according to LaVorgna.

This appraisal should allow the Fed to signal that a rate hike in March is still on the table.

However, the recent volatility in the stock markets is something that could interrupt this plan. And in fact, it is already doing the Fed’s work of tightening financial conditions, according to Morgan Stanley’s Ellen Zentner.

The FOMC’s “dot plot” of projections last month showed that it’s expecting to raise rates four times this year. Zentner argued that the dollar’s rally, falling oil prices, rising credit spreads and the stock market sell-off call for a reduction of expectations of growth and inflation forecasts.

Zentner writes:

“Wrapping it all together, there has been a substantial tightening of financial conditions since December — by our estimate the economic equivalent of four rate hikes. The Fed raises rates to tighten financial conditions, it loathes to move when the market has already done its tightening for it.”

Zentner thinks that the bar for a rate hike in March “seems insurmountable now.”

Goldman Sachs’ David Mericle echoed a similar sentiment in a client note, writing:

“Recent comments from Fed officials have indicated continued confidence in the growth outlook and only moderate concern about financial market volatility, though we think financial conditions would have to ease somewhat for the FOMC to hike again in March.”

Bank of America Merrill Lynch’s Michael Hanson thinks that markets are likely to be disappointed on Wednesday with an statement that’s not as dovish as expected.

“We think it is too early for the FOMC to capitulate on policy,” he wrote to clients. “The Fed works on a different — much slower — clock than markets.”

The one thing that could slow down the Fed’s rate-hike path is low inflation. Inflation expectations in several surveys have declined, while actual progress towards the Fed’s 2% inflation goal is slow and falling commodity prices are not helping the outlook.

On Wednesday, however, the Fed is not going to provide any new economic forecasts and there also won’t be a press conference to explain these in detail.

And so the statement really is all about how open the Fed keeps its options for subsequent rate hikes with the next big decision due in about six weeks.

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